LESSON 2: What is Development Economics? (1)

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Lesson Overview – this lesson introduces Development Economics, characteristics of developing countries and the main development issues or challenges

2.1 DEFINITIONS AND OVERVIEW

In understanding development economics, a natural starting point is to begin by defining the terms ‘Economics’ itself.

Definition of Economics – Economics is a social science subject that guides the allocation of scarce resources to meet unlimited needs and wants of a given society.

Two Main Branches of Economics (Branches of Scope)

The two main branches of Economics are microeconomics and macroeconomics.

Microeconomics

It is the analysis of economics in the small. It looks at individuals and firms; and the conditions under which they make buying, consumption and production decisions.

Macroeconomics

It is the study of aggregate economic variables such as Gross Domestic Product (GDP) growth, unemployment, inflation etc. It looks at the national dimension.

Branches of Economics by Subject

The list shown in Figure 1 is not exhaustive, as there are other sub-disciplines of economics including many that are upcoming – for example ‘space economics’ that deals with outer space. Since these other sub-disciplines are not the subject of this course (save for Development Economics), there is no further mention of them.

Figure 1 Branches  of Economics by Subject

Figure 1  of Economics by Subject

It should be noted however that there do exist a number of overlaps between and amongst these sub-disciplines. As an example, some of the topics we will cover in this course will also include aspects of environmental economics and social economics sub disciplines (and many more others).

Development Economics

After having briefly discussed some foundational aspects (just a few of them) of Economics, we can now get our focus back to the definition of development economics.

Development economics is a branch of economics that focuses on improving fiscal, economic, and social conditions in developing countries” (Bird, 2019).

This is only one definition. As cited by Mackenzie and Puffhausen (2017), the teaching content for development economics varies from one college or university to another, although there are a number of commonalities that cut across. In the same vein, there would be several other definitions of Development Economics but this should suffice. Following the great economist Amartya Sen, we can also look at development as well-being.

2.2 KEY FEATURES OF DEVELOPMENT ECONOMICS

As a complex subject, one may want to recognise and distinguish Development Economics within the broader set of relatable sub disciplines of Economics as previously discussed. To do so, there are a number of characteristics of Development Economics. Here we adopt three characteristics from Dietz Vollrath (2019)’s blog and list them. These are setting, focus and nature of inference.

Setting – It very consciously takes place in developing countries. However this statement opens up a lot of debate because many challenges faced in developing countries also manifest in developed countries – albeit with lesser incidence. The 2008 Financial Crisis for example resulted in homelessness in some developed countries as a result of foreclosures as thousands failed to honor mortgage payments – yet the effects in some developing countries were not as severe since many of them were/are not well connected to the international financial market. Hence, development economics is also relevant in developed countries. In terms of ethics and institutions, controversial activities such as share buybacks[1] are actually much more concentrated in developed countries.

Focus – It is intensely concerned with identification of causal effects. Examples are the effects of deworming on child health or the effects of land reform on welfare.

Nature of inference – The nature of inference is to an extent atheoretical. We may interpret this to mean that the subject is mostly concerned about field practicalities and realities that may not necessarily conform to theory. We may interpret this to mean that due to imperfect markets in developing countries, outcomes do not always mirror the hypothetical view. Given that development economics might have more relevance in developing countries – culture, values and norms in this setting may drive certain decisions/behaviours rather than economic theory. While in advanced countries a sitting government may be expected to behave in a rational manner that makes taxpayers happy to the extent that voters (who are also the taxpayers) will be able to vote it into power again at the next election, the same expectation may not hold in developing countries. A developing country may be trapped in a poor institutional environment such that the government may still secure an election victory even though tax payers are not happy. Here are a few reasons:

  • Taxpayers may form a very small percentage of voters due to high informality or a rural based majority
  • There may be high rates of illiteracy or ignorance of the political system
  • High levels of corruption, intimidation, lack of constitutional checks and balances (or lack of their enforcement), lack of transparency and many other factors

In the end elections in some developing countries may be held to satisfy the principle (theory) yet the process is not effective and is just a window dressing exercise.

2.3 CHARACTERISTICS OF DEVELOPING ECONOMIES

We have discussed the nature of Development Economics as a subject or some of the attributes that define it. Let us now consider some of the characteristics of developing countries. We have already talked about some of them in the previous section. Some of the most important features of developing countries are listed below and explained thereafter.

  • Low Industrial Base
  • Low Human Development Index (HDI)
  • High marginal Productivity of Capital
  • Low labour productivity
  • Poor Institutions
  • Imperfect Markets
  • Low technology proliferation
  • Raw material exporting
  • Relative land abundance
  • Plenty of challenges

Due to a low industrial base, developing countries may also be referred to as low income countries. Therefore, the term “Low and middle income countries” may also generally mean developing countries. The HDI is discussed in more detail in Lesson 3.

High marginal Productivity of Capital

Developing countries are characterised by a very low base in as far as capital is concerned. That also means a unit of capital can do more than it could do in developed countries. Developed countries are characterised by capital saturation, and it means that investor funds/loanable funds are plentiful in their supply on the market to the extent that an investor is not always able to get the first chance at the best returns project. On the other hand, developing countries are capital starved, and very good projects can spend years before attracting any funds. Thus, capital in developing countries is likely to fund the best ‘high return’ projects ceteris paribus (holding other factors constant). Secondly, given the relative absence of technology, a small amount of capital can ensure jumps in technological investment that can have an important multiplier effect on productivity, incomes and welfare. Investing in an ox-drawn plough in a peasant area in a developing country can protect the beneficiary family from hunger, potentially also allowing it to sell excess produce on the market. This would not be the same in an advanced country where the ‘ox-drawn’ plough might now be a relic found only in museums.

Low labour productivity

With the little or no proliferation of technologies that complement labour, there is also very low labour productivity (output per unit of labour) in developing countries. However, labour complementation is only part of the story. Human capital theory tells us that developing Western countries have had less children per household, allowing them to invest more per child in terms of training and education whereas in a number of developing countries societies still invest in more children per family – hence reducing the amount of money that can be invested per child. Hence, the low labour productivity.

Poor Institutions

Institutions are related to the rule of law, transparency, property rights enforcement and corruption (among other issues). Ruttan and Hayami (1984) defines institutions as the organizational or societal rules that assist in facilitating coordination by helping members of the society/organization develop expectations that form the basis of interaction. Corruption, transparency and rule of law are important topics in the development discourse because without them there is little or no development. In the words of Demsetz (1967), “property rights specify how persons may be benefited and harmed, and, therefore, who must pay whom to modify the actions taken by persons”. According to Demsetz (1967), property rights function by ensuring greater internalization of externalities by properly guiding incentives. Externalities (to be discussed in greater detail in later topics) are scenarios in which individuals are affected by a transaction that they are not party to. These effects can either be positive or negative. As an example, if politicians can unfairly benefit from ‘protection payments’ from a business, then property rights are ill-defined and institutions are not well-formed in such a jurisdiction.

Imperfect Markets

Perfect markets will be discussed in more detail later in the course in Lesson 3 (Section 3.8). Three defining conditions for perfect markets are free market entry and exit, many buyers and sellers and perfect (widely available) information. Perfect markets are free markets without any exogenous barriers or restrictions. However, in developing countries the low rates of technological proliferation may result in market imperfections. Market imperfections are distorted markets that do not reflect genuine market equilibrium. For example, for certain political ends, a government may enforce certain ideological training programs (diplomas and degrees) in a manner that do not correspond to the dictates of the market in any way, thus creating market distortions by creating an oversupply of graduates that are not sought after on the market. Due to low technological proliferation (internet for example), a recent graduate in a developing country may struggle to find a position that matches his or her profile yet in a developed country there may be job matching programs or even phone applications that match graduate profiles to jobs to create nearly a ‘perfect information’ scenario.

Low technology proliferation

Developing countries are also not as technologically advanced as their developed counterparts. The industrial revolution did not take place in many developing parts of the world, and ‘catch-up’ is the name of the ‘game’ that developing countries are currently engaged in. However, importing technology is expensive. Where developing countries do manage to import technology it is usually in the form or finished products or components for assembly. Despite the high technology costs, developing countries also have a long way to go from the perspective of increasing technical capabilities and their applications in universities.

Raw material exporting

Related to low technological proliferation, developing countries are mostly raw material exporters because they lack the technology to convert those materials into finished products.

Plenty of challenges

‘You heard that right’. In some developing countries almost nothing works. There are no proper roads, clinics, educational and recreational facilities for young people. In some developing countries there is no electricity and piped water even in urban areas. The schools and universities do not have enough capacity, and there are no proper provisions in the constitution or rather enforcement of property rights to ensure the right incentives are there to attract capital and investment.

Activity 1: Can you think about some of the development challenges that are prevalent in the developing world?

[1] Share buybacks are the practice by a company of buying off its own stock from the market as a way of keeping demand up and maintaining its value on the stock markets. Share buybacks are controversial in that critics may argue that the funds invested in share buybacks may actually be directed towards more productive use rather than creating “artificial demand”.

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